Cyprus Bailout Panic - Have Markets Peaked? 4 Ways To Profit Now

Includes: SDS, SH, SPXS, VXX
by: Christopher F. Davis

Stocks have had a strong six months as central bank action has inflated stock prices somewhat artificially with the availability of easy money. First, the European Central Bank announced an unlimited short-term bond-buying program with some conditions, reinforcing its position to do all it can to save the euro. Then the German High Court upheld the decision to back the bailout fund with few reservations beyond reviewing any proposed increases to the bailout. Following this, Ben Bernanke and the U.S. Federal Reserve announced a massive third round of quantitative easing, aka QE3, consisting of buying $40 billion in mortgage assets monthly until unemployment improves. Even the Bank of Japan is on board the central bank stimulus train and announced its own round of easing. To replace Operation Twist, the Fed most recently announced an additional spending package to bolster the economy. Now that the allure of central bank action is passing, we have turned our attention back to earnings and economic reports. We have been hovering around Dow 14,500 and just over 1535 on the S&P 500 for a few days.

Is the market bound to sell off? The answer is most likely yes, we are due for a pullback and the action in Cyprus this week could be the catalyst for a sell-off before we can start the ascent toward Dow 15,000. Some believe we could see Dow 12,000 before we see Dow 15,000. The question of whether the rally is over is on each investor's mind, both bulls and bears alike. While the economy is getting slightly better, many professionals believe earnings estimates are too high and will not be beat frequently this quarter. While I cannot predict if this rally is coming to an end or not, a correction will eventually occur. That's a fact. When the correction starts, it could happen over the course of a few weeks. Thus, traders may want to put on some bearish positions to protect or even continue to grow capital. Those who are bearish could consider selling stock, selling covered calls on their positions, shorting stocks, buying puts or investing in a volatility or bear fund. While each of these approaches has its respective benefits and risks, in this article I want to highlight five quick-pick ETFs, two volatility and three bear funds that could provide great short-term returns in the event of a market sell-off.

iPath S&P 500 Short-Term VIX futures ETN (VXX): The Chicago Board Options Exchange Market Volatility Index or the VIX, is a popular measure of the implied volatility of S&P 500 market index. You may hear it often referred to as the fear gauge or the fear index. The VIX is a measure that is supposed to represent the market's expectation of stock market volatility over the next 30-day period. The VXX is a fund that is one of the better ways to track the VIX (which is not directly available to invest in) in my opinion. This investment seeks to replicate, net of expenses, the S&P 500 VIX Short-Term Futures Total Return Index. The index offers exposure to a daily rolling long position in the first and second month VIX futures contracts and reflects the implied volatility of the S&P 500 index at various points along the volatility forward curve. The index futures roll continuously throughout each month, from the first month VIX futures contract into the second month VIX futures contract. VXX recently underwent a major one-for-four reverse split to increase share value. The fund has an annual expense ratio of 0.89%, is currently trading at $20.51, and has a 52-week trading range of $20.41-$91.52 (note this range does not account for shares reverse splitting).

ProShares Short S&P 500 (SH): This ETF seeks daily investment results that correspond to the inverse of the daily performance of the S&P 500 index. As most investors know, the S&P 500 index is a measure of large-cap United States stock performance. It is a capitalization weighted index of 500 United States operating companies and selected real estate investment trusts. SH attempts to invest at least 80% of its net assets, including any borrowings for investment purposes, to investments that, in combination, have economic characteristics that are inverse to those of the index. It intends to invest assets not invested in financial instruments, in debt instruments and/or money market instruments. The fund intends to concentrate its investments in a particular industry or group of industries to approximately the same extent the underlying index is concentrated.

SH is a low risk way to take a bearish position. It should be noted that because there is an expense fee associated with the ETF (like most ETFs) and that it seeks daily results, the investment could lose value over time in a stagnant market. The SH has an expense ratio of 0.89% annually, meaning $89 on a $10,000 investment goes to fees annually. SH currently trades at $30.82 on approximately 3.3 million shares exchanging hands daily. SH is down 0.8% in the last week, while the S&P 500, as measured by the most popular ETF that tracks the index, the SPDR S&P 500 Trust (NYSEARCA:SPY) is up by 0.25%. SH has a 52-week range of $30.77-$39.37.

ProShares UltraShort S&P 500 (SDS): For those with slightly more risk appetite seeking to make a leverage bet to the downside, SDS could be a profitable play. This leveraged fund seeks daily investment results that correspond to twice the inverse of the daily performance of the S&P 500. SDS invests in common stock issued by public companies. SDS also invests in derivatives, which are financial instruments whose value is derived from the value of an underlying asset, interest rate or index. SDS recently underwent a one-for-four reverse split to bolster the share price as the nearly four-year bull market took its toll on this fund's value. The value of shares not only depreciated from being sold down with other bearish plays during the bull market, but was also hurt by its expense ratio (0.89%) and the fact that it is adjusted daily. Funds that seek daily performance never track the long-term performance of an underlying index due to a concept known as "slippage." More on that can be found here. Despite this fact, daily leveraged funds such as the SDS, in periods of panic and bearishness, perform exceptionally well. Thus, a well-timed position can be very profitable. SDS currently trades at $44.49 a share. SDS has average daily volume of 8.9 million shares exchanging hands. In the last week, SDS is down 1.35%, while the SPY is up 0.25%. SDS has a 52-week range of $44.33-$73.04.

Direxion Daily S&P 500 Bear 3x ETF (SPXS): For those with the highest appetite for risk, besides investors who are willing to short stocks, the SPXS can be considered for heavily leveraged bearish exposure. SPXS, formerly the Direxion Daily Large Cap Bear 3X fund, seeks daily investment results before fees and expenses of 300% of the inverse of the price performance of the S&P 500 Index. As with other funds, there is no guarantee the fund will meet its stated investment objective and is subject to slippage as described above. The fund also has a higher 1.14% annual expense ratio.

Under normal circumstances, SPXS management creates short positions by investing at least 80% of its net assets in: futures contracts; options on securities, indices and futures contracts; equity caps, collars and floors; swap agreements; forward contracts; short positions; reverse repurchase agreements; ETFs; and other financial instruments that, in combination, provide leveraged and unleveraged exposure to the S&P 500. Given this approach, in times of market sell-offs, the SPXS will deliver outsized returns. Thus, this fund should be considered by those who seek to profit from panic that could result from a fast sell-off that jolts the market.

SPXS currently trades at $12.51 a share. SPXS has average daily volume of 2.0 million shares exchanging hands. In the last week, SPXS is down 1.42%, while the SPY is up 0.25%. SPXS has a 52-week trading range of $12.44-$26.83.

Conclusion: Many approaches exist to position accordingly for market panic. While we have had a great bull run in the last few months and the last few years as a whole, macro news out of Cyprus could be what triggers the next selloff, and the action following will be dictated by the next round of earnings and economic reports. I suspect markets will react negatively worldwide to this macro event and the aforementioned volatility and bearish funds will perform very well for short-term gains in response to the market panic that will ensue.

Disclaimer: I am not recommending investors to be bullish, bearish or neutral. This article is for informational purposes only and highlights funds one can consider in the event or anticipation of short-term volatility and bearishness. It is not a recommendation to buy or sell any of the aforementioned assets.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.